Is patent reform inevitable?

The first federal law related to patents was the Patent Act of 1790 and was titled “An Act to promote the Progress of Useful Arts.” In a nutshell, that’s exactly what patent law is trying to do—promote innovation. And I don’t think anyone is going to argue against innovation as a valid cause (well, maybe socialists). Interesting historical tidbit: to be granted a patent under this initial law, an individual was required to get approval from two of the following three people: the Attorney General, the Secretary of State and the Secretary of War. With over 600,000 patent applications filed in the United States just last year, I imagine John Kerry is happy this is no longer the process.

Since these first laws, the popularity of patents has ebbed and flowed throughout our country’s history. During good times people see patents as a way to promote innovation which leads to new businesses (and thus jobs) and thriving economies. During recessions patents are viewed as monopolistic devices that large companies use to crush small competitors via expensive lawsuits.

I think the wavering approval of patents throughout history is a result of the unintended consequences of patent law. Patents are great but they’re not an easy thing to get right. The modern patent system is based on the Patent Act of 1952. I’m sure those legislators 63 years ago had the best intentions, but they never could have imagined the patent industry as it is today—tech companies suing each other for billions of dollars on a regular basis and so-called “patent trolls” making millions off intellectual property for things they don’t even produce or sell. Patent trolls have been around for a long time but the tech boom also created a troll boom.

There doesn’t seem to be one agreed upon definition of what a patent troll is so let me clarify what I‘m referring to. A company that buys a patent portfolio from a bankrupt company with no intention of ever using the patents is the perfect example of a patent troll in my eyes. The troll purchases the patents with the sole intention of suing operating companies in the hopes of winning a monetary award. Many times they simply threaten to sue in the hopes that the operating company decides a lawsuit isn’t worth their time and money and agrees to pay a licensing fee. Because paying a licensing fee is often cheaper than going to court, it’s very common for the defendant to settle. I am perfectly ok with inventors who license their patents to operating companies (even though some people label them patent trolls as well).

Buying up patents with the sole purpose of suing other companies is not benefiting society in any way (unless you’re a patent attorney of course). In my opinion, if a person or company is not using or attempting to use the patent they are in possession of, they should not be allowed to file infringement lawsuits. The current law allows patent trolls to threaten litigation rather cheaply. But just the threat can cause harm, mainly through the “infringing” company that has to pay its employees and lawyers for tens or hundreds of hours of work to research the threat and plan a defense. When an infringement case is filed, the plaintiff doesn’t even have to explain how the defendant is infringing. If a plaintiff is forced to show how they are currently using (or intending to use) the patent and how the defendant is infringing, the majority of frivolous patent lawsuits (and the trolls along with them) will go away overnight.

The Innovation Act (H.R. 9) is a patent reform bill that has been in Congress since 2013 when it failed to pass the Senate. The current version of the bill was recently reintroduced and has seen some early support. One important aspect of this bill is requiring more upfront information from the plaintiff on what exactly the defendant is infringing upon. As stated above, this by itself would dissuade many vague lawsuits. Another major part is the so-called “loser pays” rule—essentially whoever loses the court case pays the other party’s attorney fees. Some people have argued this will discourage small patent holders from pursuing infringement cases in the fear that they could lose and their company bankrupted. However, there are exceptions that negate this possibility as judges will have the ability to wave the “loser pays” clause if he or she thinks the lawsuit was reasonable and justified. This bill is targeted at decreasing unnecessary patent lawsuits, not stopping legitimate inventors from defending their intellectual property.

The only thing I really disagree with in the Innovation Act is the ability of the court to make owners of the losing company personally pay the attorney fees (if their company can’t). What is the point of a limited liability company if owners can still be held personally liable in patent cases? I’m afraid this would discourage angel investors and small venture capitalists from investing in small businesses that depend on intellectual property. If an angel invests $200,000 in a small business, that should be the maximum amount of money that person can lose—not some unknown amount in a potential future patent lawsuit. In reforming our patent system it is crucial to punish patent trolls without punishing small-time inventors, innovators and entrepreneurs.

As far as investments go, two companies in this space I’ve looked at recently are Internet Patents Corp (PTNT) and RPX Corp (RPXC). Internet Patents Corp is a classic patent troll that recently won a big lawsuit against Sprint and has several more cases pending that could yield large returns. Trolls like Internet Patents Corp have created an opportunity for companies like RPX Corp which actually has a pretty good business model. RPX buys patents from operating companies and licenses them back to those same companies. They then handle all litigation related to the patents at no risk to the operating company that is now simply a licensee. RPX is an expert in this field and can probably defend lawsuits cheaper and more efficiently than the original patent owners. And as RPX builds their portfolio of patents, (at least theoretically) they spread those litigation costs over more and more clients thus decreasing their licensing fees and creating a bit of a network effect. Like I said, not a bad business model at all.

If you think the current patent landscape in America is not changing anytime soon I highly recommend looking into both of these companies. I don’t know if it’ll happen next year or ten years from now but I think major patent reform is inevitable which is why I consider this space uninvestable right now. Even if patent trolls aren’t done away with completely, one thing legislators have been pushing for is more transparency in these infringement cases. In other words, if a patent troll is backed by a large corporation it must be revealed in the lawsuit. Likewise, if the defendant is not the company actually using the patent, the operating company can be brought into the lawsuit as well. This would make a company like RPX relatively pointless.

Not directly related to trolls but still in the patent sphere, it’s great to see some of the world’s biggest companies trying to do away with patent lawsuits. Apple and Google famously spent millions suing each other over various intellectual property claims before calling a truce and dismissing all lawsuits last year. I can’t say it any better than Julie Samuels, an intellectual property lawyer, did in that linked article: “Instead of spending millions of dollars enriching patent lawyers, they’ll put those resources into real competition.” Around that same time Elon Musk released all of Tesla’s patents for the world to see and use. His reasoning? Other car makers are nowhere near Tesla’s capability and they need to catch up—fast. More car manufacturers producing more electric cars that are more efficient is better for the world. Whether that is good or bad for Tesla is a secondary concern—at least that’s what Tesla’s PR people say 🙂

Patents can stifle innovation through decreased competition but they also promote innovation by giving the small inventor/entrepreneur time to build and grow a company before large corporations are allowed to copy what he or she created. This gives the individual an opportunity for immense profits and the motivation to innovate in the first place. I think patents are a great thing for an entrepreneurial, capitalistic society but there are many unintended consequences that can be done away with—starting with patent trolls.

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This blog is for informational purposes only. Everything on this blog is the opinion of Travis Wiedower and should not be taken as investment advice. Clients of Wiedower Capital may maintain positions in securities discussed on this blog.